DUBLIN, March 13 (Reuters) - Ireland took its biggest step yet towards exiting its European bailout later this year by selling 5 billion euros ($6.5 billion) of new benchmark 10-year bonds on Wednesday to meet nearly all its funding needs through next year.

Rescued two-and-a-half years ago after being overwhelmed by fiscal and banking crises, Ireland has hit every major target since and has been held up by euro zone leaders as the success story their austere plans desperately need.

The government hailed the sale as proof that Ireland can soon end its dependence on 85 billion euros in rescue loans it received from the European Union and International Monetary Fund. It has been helped by a fall in yields for its debt, now lower than those of Spain or Italy, euro zone countries that, though troubled, have not been driven to sovereign bailouts.

“There has been an extraordinary response to it and I don’t think you will have heard me use the word extraordinary before,” Finance Minister Michael Noonan told a news conference after the sale.

“This brings us within about a billion and a half towards what we need to the end of 2014. That puts us in a very strong position. A lot of ministers visiting various countries for Patrick’s Day will have a fairly impressive piece of news.”

The sale was Dublin’s biggest market test to date after resuming borrowing last year, and raised as much as double the amount that many traders had predicted would be offered. Even then, it was highly over-subscribed, with offers of 13 billion euros, the National Treasury Management Agency (NTMA) said.

The much anticipated issue was Ireland’s first sale of such long term debt since it was locked out of markets in late 2010.

The yield on the new debt was 4.15 percent compared to 4.7 percent in Italy and 4.8 percent in Spain.

Ireland’s current benchmark 2020 bond yields 3.7 percent in secondary markets, a huge improvement from the 15 percent it yielded at the height of the euro zone crisis in mid-2011.

Ireland currently pays an average of 3.5 percent for funding from its rescue fund.

Wednesday’s deal also moves Dublin closer to qualifying for the European Central Bank’s new OMT bond-buying scheme, which requires a country to have secured “normal market access”.

“I think that should be regarded as a resumption of normal access to the markets .. that’s our judgment,” NTMA chief executive John Corrigan told a conference call.

The OMT scheme is not an immediate priority for the government, he added, with the focus rather the securing of a conditional line of credit from the International Monetary Fund.

The bond issue could also convince Moody’s, the only rating agency that ranks Ireland’s debt as ‘junk’, to at least change its outlook to stable. Moody’s described the deal as a credit positive step in Ireland’s efforts to regain market access.

“Either the market is wrong or Moody’s is wrong and I’m betting with the market,” Corrigan said.

Together with the sale of 2.5 billion euros of five-year debt in January and the 1.3 billion recouped last month from selling a state-rescued insurer, Ireland is now very close to the 10 billion euros it has targeted to raise this year and any additional fundraising will be very light, Corrigan said.

LINGERING CONCERNS

But while the deal underlines the confidence investors have in the Irish government, it will offer little relief to taxpayers who face at least three more years of austerity to meet strict European Union-enforced deficit targets.

Although Ireland has avoided joining the rest of the euro zone in recession and expects robust exports to deliver a third year of tepid economic growth in 2013, the domestic economy continues to struggle under the weight of relentless austerity.

Unemployment, while stabilising, remains above 14 percent with over half of those out of work for a year or more. The jobless rate would have hit 20 percent had emigration not risen four-fold from the “Celtic Tiger” boom years of the 2000s.

Ireland’s almost wholly state-owned banks, pushed to the brink when a property bubble spectacularly burst in 2008, are only slowly recovering. The government unveiled a new plan on Wednesday calling for more action on their most troubled area of mortgage arrears.

“This issue continues the run of good news, but there are still many delicate steps to be taken before Ireland returns to economic health,” said Austin Hughes, chief economist with KBC Bank.

“It shows there is positive sentiment in financial markets, but the second and arguably more important element is to gently encourage a rebound in economic activity.”